I've written about Brazil pre-Lula and post-Lula and spent the last five years covering all aspects of the country for Dow Jones, Wall Street Journal and Barron's. Meanwhile, for an undetermined amount of time, and with a little help from my friends, I will be parachuting primarily into Brazil, Russia, India and China. But will also be on the look out for interesting business stories and investing ideas throughout the emerging markets.

Interest Rate Hikes Could Pull Rug Out From Brazil Rebound

Brazil equities are on the rise after being one of the worst performing emerging markets around, but investors will eventually have to weigh what higher interest rates are going to mean for this market.

On Thursday, the iShares MSCI Brazil (EWZ) exchange traded fund was up half a percent to $44.21. The ETF is up over $4 in the last two weeks, but is still underperforming the broad MSCI Emerging Markets Index. Surprisingly, the uptick in Brazil equities comes at a time when the Central Bank has gone decisively hawkish and now analysts at Nomura and BarclaysBarclays are expecting interest rates to end the year around 9.25%. Rates are now 8.5%.

The minutes to the July meeting of the rate-setting Monetary Policy committee of the Central Bank of Brazil (BCB) delivered a surprisingly hawkish message. It discounts recent weakness in activity data and aims its focus squarely on the inflationary impacts of a weaker currency. The real is trading at R$2.22 to the dollar, down over 8% this year. This is the longest period of Brazilian real weakness since the late 2008-09 crisis that took the real in the R$2.40 range.

Tony Volpon, head of emerging markets Americas at Nomura in New York, says part of the recent rate hikes could be permanent in nature, especially as the Bank reassesses the world economy. There’s a slowdown in China. And a recession in major European markets. This means less demand for Brazil’s biggest export items, from beef to soybeans, iron ore to orange juice.

Despite that recognition, the Central Bank might be getting ahead of itself yet again with its economic forecasting, saying growth prospects look solid even in this environment.

Investors have heard this before.

Volpon said he expects another 50 basis points hike at the upcoming August Copom meeting and maintains his view that this cycle will take the benchmark Selic rate to the 9.25% level by year’s end.

Domestically, the monetary authority continues to emphasize that tight labor market conditions are a source of concern for the inflationary outlook and its base case scenario contemplates a stronger pace of economic activity in Brazil this and next year. But that will depend on sentiment, which is sour at the moment. This remains a source of concern for the Central Bank. The risk being that if sentiment fails to recover, it could pose downside risks to domestic growth, seen at around 2.5% this year.

On the inflation simulations, the Central Bank sees the core inflation above 4.5% this year but it is unchanged in comparison to the last meeting minutes.

“The pressure from within the government to moderate the pace of tightening in the August meeting should escalate strongly,” says Marcelo Salomon, an economist at Barclays Capital. He too expects the Selic to end up at 9.25% before the Central Bank surveys the land once again and investors shift their focus to an election year.

Post Your Comment

Post Your Reply

Forbes writers have the ability to call out member comments they find particularly interesting. Called-out comments are highlighted across the Forbes network. You'll be notified if your comment is called out.